Final Exam

Question 1

Net working capital equation

Answer 1

NWC=Current assets- current liabilities

Question 2

EAR

Answer 2

Effective annual interest rate: annualized interest rate using compound interest

Question 3

APR

Answer 3

Annual percentage rate: interest rate annualized using simple interest

Question 4

Perpetuity

Answer 4

Constant stream of cash that lasts forever

Question 5

Annuity

Answer 5

A stream of constant cash flows that lasts for a fixed number of periods

Question 6

3 steps to a mortgage interest rate

Answer 6

1. APR is the posted rate and will be semi annual compounding, so for every 6 months is APR/2
2. EAR is the posted rate compounded on s semi annual bases
   3.Monthly rate: the interest rate paid every month, when compounded monthly is equal to EAR

Question 7

Coupon Rate

Answer 7

the annual coupon payment on the bond dividend by the face value of the bond

Question 8

Pure Discount bond

Answer 8

pays no coupons only repays its face value at maturity (T-bills)

Question 9

Level coupon bond

Answer 9

make periodic coupon payments in addition to the maturity value, where the payments are equal each period

Question 10

Consols

Answer 10

is a perpetual bond and pays fixed coupon annually (PV of a perpetuity)

Question 11

YTM

Answer 11

Yield to maturity: the annual interest rate which makes the present value of the bonds cash flows equal to its current price

Question 12

3 reasons for high PE ratios

Answer 12

high growth opportunities, low risk, conservative accounting principles

Question 13

What is the difference between geometric and arithmetic average

Answer 13

geometric average will be less than arithmetic average unless all returns are equal

Question 14

What is the problem with arithmetic average

Answer 14

arithmetic is overly optimistic for long horizons

Question 15

What is the problem with geometric average

Answer 15

geometric is overly pessemistic for short horizons

Question 16

Systematic risk

Answer 16

risks that can not be eliminated from a portfolio and are caused by macroeconomic factors and is measured by Beta

Question 17

What is beta

Answer 17

the measure of sensitivity of a stocks returns to the returns on the market, in other words the systematic risk

Question 18

Defensive stock

Answer 18

when Beta is lower than one, which means when there is a 1% change in market returns , the change in returns will be less than 1%

Question 19

Aggressive stock

Answer 19

When Beta is greater than one, then given a 1% change in market returns, the change in the stock returns will be more than 1%

Question 20

Beta of a T-bill

Answer 20

returns on a t bill are fixed therefor beta is 0

Question 21

Payback period rule

Answer 21

Accept a project if its payback period is less than the specified cutoff period

Question 22

cons of payback period

Answer 22

ignores time value of money, ignores cash flows after payback period, biased against long term projects, requires an arbitrary acceptance criteria, may not have positive NPV

Question 23

Discounted payback

Answer 23

the time period it takes for the discounted flows generated by the project to cover the initial investment in the project

Question 24

IRR Rule

Answer 24

internal rate of return, accept a project if its IRR is higher than the opportunity cost of capital (similar to YTM questions just using IRR as interest rate) it will be the rate that makes return equal to 0.

Question 25

PI rule

Answer 25

profitability index, accept an independent project if PI>1, for firms with capital budgeting issues, choose the projects that fit the budget and maximize PI

Question 26

Incremental cash flow equation

Answer 26

=Cash flow with the project - cash flow without the project

Question 27

What are the four factors to look out for when considering incremental cash flow

Answer 27

forget sunk costs, include opportunity costs, include all side effects, beware of allocated costs

Question 28

Define CCA and UCC

Answer 28

Capital Cost allowance is the amount of write-off on depreciable assets allowed by the CRA against taxable income
Undepreciated capital cost, the balance remaining in an asset class that has not yet been depreciated in that year